Economics 980: Topics in Market Design

Official Course Description: This course studies the design of organized markets, focusing on efficient organization and the incentives created by market rules. Applications include online auction markets, government auctions of natural resources, matching markets (students to classes or schools, medical residents to hospitals, kidneys to recipients), health care markets, and electricity markets. The analysis relies on a mix of documenting the rules of real-world markets, game theoretic analysis, empirical analysis, and experimental work.

Economics Department Rules for Junior Seminars: All junior seminars require a major research paper; the prerequisites are intermediate microeconomic and macroeconomic theory, statistics, and econometrics (concurrent enrollment in econometrics is sufficient). Junior seminars therefore satisfy both the writing requirement and the theory prerequisite requirement for the Economics concentration. Each seminar is limited to 16 participants with preference given to honors Economics and Applied Math/Economics concentrators in their junior year. Enrollment will be determined by a lottery based on student preferences.

Class Format: Theory classes will be in lecture format. Application classes will require reading and preparation for discussion, guided by discussion questions. For most application classes, two students will prepare short presentations and/or take a leading role in the discussions.

Projects: Look for some ideas for research projects. This will be updated according to student interest. Here is a handout with guidelines for the project and due dates.

Reading List: Download the reading list. Only a subset of papers will be covered.

Overview: Market design is an area of study that cuts across traditional field boundaries in economics. It is broadly defined by the idea that in many cases, markets are or could be designed by entities such as governments or participants in the marketplace. Economists focus on a number of issues when considering market design, including: efficient allocation, incentives for participants to reveal their information directly or indirectly to the mechanism, transparency, simplicity/computational complexity, vulnerability to manipulation or collusion among participants, revenue generation for the market designer (in some cases), distribution of resources. In many examples, different market designs compete; in some cases, one market design becomes dominant, but in others, different markets with different rules co-exist.

The examples below illustrate the kinds of markets and questions we will consider. In almost all of these examples, academic economists have played a prominent role in shaping the rules of the markets. We won’t have time to consider all of these examples, and preferences from the class will be considered in determining topics.

• In auction markets, the auctioneer (often a government) wishes to procure supplies or allocate natural resources, and the government sets the rules for participation and bidding. The government values efficient allocation and revenue generation.
• eBay and other online auction houses design (and constantly refine) the rules and institutions of the marketplace, including bidding rules, information feedback to the bidders, and mechanisms for establishing and maintaining reputations. eBay is the dominant marketplace for small sellers. It is a profit-maximizing firm.
• Google, Yahoo! and Microsoft Live sell sponsored links associated with keyword search using auctions. This multi-billion dollar industry is growing fast, and the sponsored link concept has extended its reach to “contextual” advertising on content sites that contain keywords specified by advertisers. Early auction designs were flawed and lead to inefficient outcomes. The search engines continue to update their rules in an effort to maximize revenue and efficiency.
• As the multi-billion dollar online advertising market grows, a number of “advertising networks” and “advertising exchanges” have been created to bring together advertisers and publishers. Google is attempting to buy DoubleClick, which has one of the largest advertising networks. The networks use information about consumers from their accounts with various entities (e.g. Gmail) and their past search, purchase, and reading behavior to serve targeted advertisements. It is not clear at this time which market designs for online advertising platforms will be successful, and the market designs and business models are rapidly evolving.
• Governments around the world have designed complex, multi-billion dollar auctions for spectrum to be used for mobile phones and other devices, and leading auction theorists designed entirely new auction mechanisms to solve this problem. Efficiency and revenue generation are primary objectives, but in cases where hundreds of objects are allocated simultaneously (e.g. licenses for cell phone service in all U.S. markets), computational complexity also plays a crucial role.
• Markets for emissions (pollution permits) have also been designed by governments, and auctions for tradeable permits have been used.The goal is pollution reduction at least social cost.
• The deregulation of electricity markets have lead governments to set the rules, and structure, of electricity markets, including auction markets for the supply of electricity. Ideally markets should provide incentives for appropriate investment in generation capacity and transmission, as well as for delivering electricity when it is most needed.
• In matching markets, participants use a centralized procedure to match roommates to rooms, students to schools or classes, medical residents to residency positions at hospitals, kidney donors to kidney recipients.In this set of examples, money plays little or no role in determining the match, and so the mechanism faces special challenges in eliciting information about preferences.
• Markets for the provision of health care are highly regulated, and the government sets rules governing competition for patients covered by its health plans. Candidates in the upcoming election are proposing different alternatives for health care reform. Different countries offer different systems. Ideally markets should deliver the efficient level of care to patients for the least cost, while providing incentives for: (i) doctors and patients to engage in appropriate preventative care, (ii) hospitals to invest in the appropriate technology, (iii) drug companies and researchers to develop new, innovative, and cost-effective cures for disease.
• In two-sided markets, a platform brings together two kinds of agents for a transaction, and sets prices and fees for both sides. Examples include:

Rough Schedule:

This is subject to change.

9/19 Introduction to Market Design, and Overview of Potential Research Problems (1 class)

Part I: Auctions

9/26 Introduction to Game Theory and Auction Theory

Read:McAfee,R.Prestonand John McMillan.1987. “Auctions and Bidding.”Journal of Economic Literature, 25, 699-738.

10/3 Extensions to the Basic Auction Model

Read: Ausubel, Lawrence M. and Peter Cramton.2004. “Auctioning Many Divisible Goods,” Journal of the European Economic Association, 2, 480-493.

10/10, 10/17, 10/24: Applications of Auctions (3 classes) (Online, Timber, Spectrum)

Part II: Two-Sided Markets

10/31, 11/7, 11/14:Basic theoryand applications (Media, Advertising Networks/Exchanges, Dating)

Part III: Matching Markets

11/21, 11/28 Basic theory (.5 class) and applications (1.5 classes) (Residencies and Law Clerks, Kidney exchanges, School Choice) (11/28 is guest lecture by Al Roth)

Part IV: Health Care Markets

12/5 Basic theory (1 class)

12/12 Comparing reform proposals (1 class) (David Cutler guest lecture)